Friday, 4 January 2013

Macroeconomic Theory and the Multiplier

I agree with most of what John Quiggin says in his post on
fiscal multipliers, but I started having problems towards the end when he
writes:

“To sum up, despite the thousands of papers published every
year in the field, macroeconomic theory is incapable of giving even a
qualitative answer to the most basic questions about fiscal policy[3]; at
least, not one that would not elicit dissent from a substantial, and
well-credentialled group of leading experts.”

The footnote reads

“[3] While writing this, I wondered what would happen if you
put this question to a group of DSGE theorists as a pop quiz. I suspect most
would give some variant of “the question is ill-posed” and the rest would be
all over the place. But, if any DSGE theorists are reading, I’d be keen to get
their views.”

OK, I have written a fair number of published DSGE papers on
fiscal policy over the last decade, so here is my response. New Keynesian
theory, and therefore the New Neoclassical synthesis, provides pretty clear
answers to the multiplier question. I have talked about this before so I will not
repeat these answers here. Macroeconomic theory is ‘all over the place’ on many
issues, but this is not one of them.
I would go further.
If policymakers had paid more attention to theory, and less to a well known
piece of empirical work, they would have been less likely to have made the
mistakes they have.

The problem is not ambivalent theory, but the fact that a
large section of macroeconomists choose to ignore or discount the relevant
theory. Now this is actually consistent with the sentence from John Quiggin’s
post that I quote above, because of the part that says ‘at least ....’. So in
that sense it is a quibble. But I think it is an important quibble. There is a
great deal of difference between suggesting that theory is all over the place,
and saying that a large body of theory – the theory used by nearly all monetary
policymakers – is pretty clear, but that a significant group of economists do
not accept it.

The difference comes in the following paragraph, where he
says “It really is hard for me to see how the economics profession can recover
from its current rotten state, at least as regards macro..” If a large section
of the profession (perhaps even a majority) subscribes to the New Neoclassical
synthesis framework, and that framework is sound (if far from perfect), then we
still have a problem, but one that does have solutions.

What stops you? To seriously, theoretically disagree, I mean. I'd even dare to say that even half-baked, non-serious disagreements will enjoy a publication and popular support. There is a lot of demand for papers that estimate fiscal multiplier to be less than one, zero or negative...

Simplify your understanding. Simplify the math. Unify the concepts.This is what my research is doing...You can find it here.

https://docs.google.com/open?id=0BzqyF_-6xLVET1dkQ0VDenRRTjQ

The equations use simple math yet they are really good. The equations have determined that the natural rate of unemployment has risen, while other models aren't sure. The equations show a deeper view of the Solow growth model. and more... My equations would have seen the problems in the economy 10 years ago. But I only just discovered these equations within the last 2 months.

The Finance Minister is overawed and not looking forward to his weekly meeting with the boss. How will he be able to explain to his law-educated PM that (a) the velocity of money changed, and (b) the fiscal multiplier was under estimated? He can offer the head of the Chairman of Economic Advisers but the Governor of the Bank is on a fixed term contract....

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